Submission to The Board of Taxation
Post-implementation review of the
small business capital gains tax (CGT) concessions
Discussion paper – February 2005
Introduction
In response to the February 2005 Discussion Paper on the postimplementation review of the small business capital gains tax (CGT)
concessions, the following submission is provided on behalf of the
Association of Grant Thornton firms in Australia. As you are aware,
Grant Thornton firms are prominent worldwide in advising owners of
growing entrepreneurial and owner managed businesses. We specialise
in issues that affect privately owned business groups.
Our submission is separated into general comments and specific
comments. The general comments are in relation to broad issues arising
from the approach of Treasury to this issue. The specific comments are
based on specific circumstances that we have come across.
We understand that:
•
The Consultation Plan for the CGT review outlines how the Board of
Taxation proposes to undertake a post-implementation review of the
small business CGT concessions in Division 152 of the Income Tax
Assessment Act 1997 (“Act”).
•
The Board will be assessing the quality and effectiveness of the small
business concessions and will have regard to the extent to which the
legislation:
•
-
gives effect to the Government’s intent, with compliance and
administration costs commensurate with those foreshadowed in
the Regulation Impact Statement for the measure
-
is expressed in a clear, simple, comprehensible and workable
manner
-
avoids unintended consequences of a substantive nature
-
takes account of actual taxpayer circumstances and commercial
practices
-
is consistent with other tax legislation
-
provides certainty
A statement of the Government’s policy intent that underlies the
small business CGT concessions was included as an attachment in
the Consultation Plan and the Board will not be seeking to revisit this
policy intent, but to examine how effectively the policy intent has
been translated into legislation.
Page 2 of 10
1.
General Comments
1.1
It is submitted that the Division 152 CGT concession provisions fail the
main criteria by which the Board is assessing their quality and
effectiveness.
1.2
In particular, for a small business concession, the division is overly
complicated and in many cases unworkable, and fails to support the
underlying policy by inadequately dealing with the realities of small
business structures and commercial practice.
1.3
The $5M net asset value threshold needs to be thoroughly reviewed, in
terms of:
•
how and when that net value is to be determined; and
•
whether $5M is an appropriate threshold
1.4
Presently, the law imposes an unnecessary compliance burden on
taxpayers to determine the value of their net assets. We also believe
that the policy of the legislation would be better supported by phasing
the concession so that it is not “all or nothing”.
1.5
Further, the requirement to have a controlling individual to access
certain concessions is, in practice, denying concessions to parties who,
in accordance with the policy of the legislation, should be entitled to the
concessions. Family owned business structures often have more than
two stakeholders who should be entitled to the concession on the sale
of their interests.
1.6
We believe that the policy of the legislation would also be better
supported by allowing the ‘flow through” of concession derived by a
company or unit trust to its members (as the Division 152B concession
presently does).
Page 3 of 10
2.
Specific Comments
2.1
We have approached this part of our submission by outlining a number
of circumstances that we have identified in which the CGT concessions
have been, in our view, inadequate.
2.2
In relation to each of these situations, we have tried to highlight the area
of the law that we believe needs review, and the practical problems that
have arisen or could arise in these circumstances.
Active Assets
2.3
Legislative clarification is needed regarding what assets of an entity
are “active” assets. Further, in practice, it is extremely difficult, time
consuming and costly to test whether an asset has been “active” during
at least half of the period of ownership of the asset. This point is
illustrated by the example contained in Appendix 1, which considers
whether shares in a company (and therefore the company itself) are
“active”.
2.4
Generally, shares in a company or interests in a unit trust are active
assets provided:
•
the market value of the active assets of the company or trust is 80%
or more of the market value of all assets of the company or trust;
and
•
the above is satisfied within the time period stipulated by the active
asset test
In order to satisfy the test, the shareholder must be able to evidence and
support the fact that during the period the 80% requirement was
satisfied. Application of this would require some form of valuations and
regular calculations to ensure the requirement is met. For long periods
of ownership (more than 5 years) this would prove, time consuming and
costly. Work undertaken to satisfy this test in such situations is an
excessive compliance burden.
2.5
It is unclear whether the “active asset” test contained in section 152-40
has a “cascading” effect where active assets are held through a chain of
companies, as diagrammatically represented in Appendix 2. For
example, can it be said that if Company 3’s shares are active, then so too
are company 2’s and company 1’s such that a sale, by the individuals, of
the shares in company 1 would be the sale of “active” assets? We
understand that via the NTLG CGT liaison committee the answer is
“yes”, however legislative clarification is required.
Page 4 of 10
2.6
The current state of the legislation is biased towards the sale of shares /
interests in a unit trust. This is on the basis that the application of the
concession to the sale of assets by the entity will give rise to a
concessionally taxed capital gain being distributed to an individual
shareholder / unitholder which would attract personal tax at marginal
tax rates. Such a bias is not reflective of commercial transactions where
potential buyers of small businesses, being anxious to limit the risk of
being exposed to undisclosed liabilities, will usually favour purchase of
a business rather than an entity.
The $5M threshold
2.7
It is submitted that the $5M threshold is too low in that it does not
accurately reflect the value of small businesses in Australia. In addition,
the fact that the $5M limit is not indexed on a year by year basis means
that fewer and fewer businesses will be able to utilise the concessions
contained in Division 152 over time. It is submitted that the $5M should
be indexed on a year by year basis in accordance with a measure of
economic activity such as growth in GDP or CPI movement.
2.8
We further submit that the $500,000 lifetime limit for applying the
retirement exemption in subdivision 152-D should also be changed and
indexed annually for the same reasons stated in 2.7 above.
Asset value test – principal place of residence
2.9
Where the CGT asset sold is held directly by an individual, the principal
place of residence is not included in calculating the net asset value
(“NAV”). However, where the asset sold is a share in a company or an
interest in a trust, the principal place of residence is included in the NAV
if it is held by the entity.
2.10
Connected entities are essentially determined by establishing a level of
control (generally 40% or more of rights).
In relation to a discretionary trust, control is also deemed to be with a
trustee or other party that determines how the trustee exercises its
powers (such as an appointor).
Page 5 of 10
In a family entity structure where individuals may themselves be the
trustees or directors of a corporate trustee of a family trust, the family
trust will be connected with the individuals and the value of the
individual aggregated with that of the trust under the connected entity
test. This sometimes produces extremely inequitable consequences
when the family trust holds assets for the generational benefit of a family
which may be divorced from the business assets of, say, a company
owned by the individual trustees that is functionally separate from the
trust and practically unrelated. Mere trusteeship of a trust should not
mean the trustee and the trust are connected in all circumstances.
Excluded superannuation fund assets – committed entities
2.11
In relation to the net value tests, you disregard the value of rights to an
asset of a superannuation fund – if you are working out the value of an
individual. If the entity is a company, and an individual is connected
with that company, section 152-20 does not appear to exclude the
individual’s superannuation fund assets from the net asset value
calculation. This appears to be manifestly unfair and unintended and
the law should be amended to exclude the value of all superannuation
fund assets – of the entity, and connected entities as appropriate.
Controlling individual test
2.12
Currently the concession does not apply to individuals where husband 1
and wife 1 and husband 2 and wife 2 each own a 25% interest in a
company.
Assume that the company sells its business to a third party, which
includes the sale of post-CGT assets. The company is entitled to the
50% active asset concession. Were the individual shareholders to sell
their shares, each shareholder would not be entitled to any of the
concession. The denial of the concession is based on no one
shareholder being a “controlling individual”. The “controlling
individual” test requires one individual to hold at least 50% interest in
the company.
In our opinion, the ownership structure of the company and access to
Division 152 concessions is unfairly restricted by the definition of
“controlling individual”. Yet in this simple example, the individuals
should be entitled to the concession and not denied on the basis of their
shareholding pattern/structure.
Page 6 of 10
2.13
The recent changes made to the controlling individual test whereby an
individual is deemed to control a trust in accordance with distributions
that have been made in prior years, needs reviewing. There are a
number of legitimate reasons why a distribution from the trust may have
been made in a particular year to a particular beneficiary that may not
ordinarily receive any distribution at all from the trust. Innocently
making such a distribution can mean that that beneficiary’s assets are
included for the purposes of the $5M net asset test, possibly resulting in
the $5M test being breached. It is submitted that the law has too rigid
an application in this regard and should be rewritten.
2.14
The commercial reality is that a majority of small business structures
utilise a discretionary trust to own shares in a company conducting the
business. As such, the company does not have a “controlling individual”
and the small business concessions cannot therefore be accessed where
the trust sells its shares.
Given the prevalence of such structures, consideration should be given
to providing a legislative “look-through” of the trust to the beneficiaries.
A test similar to the “control test” could then be used to determine if
there is, in essence, a “controlling individual” of the company.
15-year exemption
2.15
Even where an asset has been held by a company for more than 15
years, s152-105(c) requires that “at all times during the period for which
you owned the CGT asset, the company… had a controlling individual”.
In other words, the exemption is premised on the basis of a controlling
individual throughout the ownership period. The “at all times”
requirement bears no correlation to the 15 year period which is the
minimum requirement of the exemption. This additional requirement
should be removed.
Page 7 of 10
Appendix 1- Active Asset Test
Active Asset – analysis of ABC Pty Ltd Balance Sheet
2003
Cash at bank
Cash deposits
Other
Trade debtors
Shareholders loans
Investments
Plant & equipment
Goodwill
Total assets
Total active assets
% active assets
Cash at bank
Cash deposits
Other
Trade debtors
Shareholders loans
Investments
Plant & equipment
Goodwill
Total assets
Total active assets
% active assets
2002
2000
1999
554
0
0
0
575
557
345,161 661,231
246,885 254,911
0
0
3,422
6,308
300,000 250,000
896,567 1,173,007
649,712 918,096
72%
78%
FAIL
FAIL
0
0
674
818,973
229,189
0
12,571
130,000
1,191,407
962,218
81%
PASS
1998
1997
1996
1995
21,744
0
28,709
5,850
0
0
500
500
914
436
556
580
560,020 949,395 1,143,433 558,683
229,188
216,246 169,295 183,131
0
0
4,612
0
16,580
14,389
19,097
23,879
400,000 250,000 350,000 550,000
1,239,238 1,430,466 1,716,202 1,322,623
999,258 1,214,220 1,541,795 1,138,992
81%
85%
90%
86%
PASS
PASS
PASS
PASS
1994
0
1,869
300
408,962
192,527
0
31,580
300,000
935,238
740,842
79%
FAIL
3,782
18,146
0
0
430
467
508,905
428,709
261,701
250,273
0
0
21,800
21,424
730,000
580,000
1,526,618 1,299,019
1,264,917 1,048,746
83%
81%
PASS
PASS
2001
Page 8 of 10
Cash at bank
Cash deposits
Other
Trade debtors
Shareholders loans
Investments
Plant & equipment
Goodwill
Total assets
Total active assets
% active assets
1993
1992
1991
1990
1,984
228,977
300
166,425
171,107
0
35,981
225,000
829,744
429,690
52%
FAIL
0
1,592
300
148,173
128,222
0
40,021
120,000
438,308
308,494
70%
FAIL
60,821
500
300
205,517
102,014
0
48,694
120,000
537,846
435,332
81%
PASS
36,752
500
301
266,433
69,199
100,000
43,517
120,000
636,702
467,003
73%
FAIL
Conclusion
•
•
Years passed:
Years failed:
8
6
therefore, active asset test is passed
Page 9 of 10
Appendix 2
Individual 1
Individual 2
50%
50%
Company 1
100%
Company 2
100%
Company 3
Active assets / business
Page 10 of 10